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Tuesday, April 1, 2008

The Absurdity of More Mortgage Regulations

Here in Illinois, we have several state laws that demonstrate the absurdity of creating even more regulation. For instance, we have something known as Illinois high cost law. Illinois High Cost limits not only the maximum rate but also the maximum in fees. In Illinois, the maximum fees that can be charged are 5.5% and the maximum rate about 11% APR though there is a lot of interpretation on that matter.

Now, the Illinois High Cost law used to be even more complicated. That's because it used to be that any loan with a rate above 8% used to allow only 3% in fees maximum. With the fees being maximized at 3%, that made some loans very difficult to do. Imagine a loan for 90k. Normal closing costs run just above 2k total. In that scenario, the loan officer is left with less than 1% in fees to charge. In fact, this separate 3% rule only discouraged most mortgage brokers from seeking smaller loans with poorer credit.

Even today, Illinois High Cost can cause all sorts of problems. One of the biggest problems it causes is on ARM's (Adjustable Rate Mortgages) who's rates approach 11%. That's because ARM's are only fixed for a certain period of time and then they adjust. Well, it is impossible to project what rate it will adjust to. Thus, that is left to a computer. Many times, brokers fees are cut at the last minute when final numbers are determined by a software system. The most egregious example happened to my protege whose loan was approved and ready to close when the bank determined that it didn't exceeded Illinois High Cost laws.

Some maybe looking at the 11% figure and saying that brokers shouldn't charge that anyway, but keep in mind that 11% rates are found on loans for folks with serious derogatory credit issues. By having a high cost law, those folks have even more difficulty getting loans.

Illinois High Cost left a lot of room for interpretation. For instance, many times banks would be able to bring their loans into compliance by tinkering with the margins on the ARM's. The whole process is quite complicated, and ultimately it is unclear what effect it would have on the mortgage, but what it would do is turn an illegal loan into a legal one.

Finally, Illinois High Cost leaves a lot of interpretation when it is combined with other regulations. For instance, an FHA loan has this up front fee called MIP. This is collected by FHA itself. Now, in Illinois, some banks consider the MIP toward the 5.5% limit and others don't. One time, I credit a borrower's closing costs (a fancy term for paying for the borrower's closing costs) and still ran into Illinois High Cost issues using FHA. That's because FHA doesn't see credits as a reduction in costs. As such, when the two rules were combined together I was technically in violation.

if you are confused, you should be however don't think for one minute that professionals aren't just as confused. Illinois High Cost is one law in one state, but the reality is that each state has their own state laws, which combine with national laws, and those combine with other rules and regulations of each specific loan product to make mortgage professionals feel like mice in a maze.

It is absurd to think that more regulation will help. This industry is hyper regulated as it is. In fact, there are so many rules that it is near impossible for most people to keep track. Yet, what some politicians are proposing is even more rules. Politicians will throw out terms like transparency, accountability, and competence, however in practicality they will have the effect that Illinois High Cost has had.

In Illinois, we had another law that was supposed to bring the elusive transparency to the process, the Illinois Fairness in Lending Act. This law created a disclosure called, the Net Tangible Benefits Disclosure. This disclosure clearly spelled out why the borrower was doing the loan (lower rate, lower payment, consolidate debts, get a fixed rate, etc.) The only practical effect of this law was that folks in Illinois had to sign one more disclosure than most others.

That is what most people are not realizing in this debate. During the loan process, a borrower will sign their names over one hundred times. The reason there is so much signing necessary is that there are so many regulations already. Banks create disclosures that are meant to deal with a certain regulation. There are so many regulations already that borrowers need to sign over one hundred documents already.

This crisis wasn't caused because there wasn't enough regulations in place but rather that the regulations weren't enforced. The reason that this crisis happened is because everyone involved, including the borrower, accepted what was obviously an absurd loan. Brokers aren't technically allowed to misstate income however if the bank accepts the income there is no rule violation.
The only practical effect of adding more regulations is to make an already maddening process even more bureaucratic and time consuming.

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